Why oil and natural gas prices have traded down recently (Part 2 of 4)
Last week, natural gas prices closed at $4.43 per MMBtu
The front month contract for natural gas closed at $4.43 per MMBtu (millions of British thermal units) on March 14, marginally lower than the prior week’s close of $4.61 per MMBtu.
Over the past few weeks, prices had been highly volatile, as severe winter weather caused surges in natural gas demand. Natural gas is used for home heating and electricity, and the recent cold caused the price of the benchmark natural gas contract (Henry Hub) to spike above $6 per MMBtu during the third week of February—the highest levels since late 2008. As winter weather winds down, prices have fallen back to levels of ~$4.50 per MMBtu, and natural gas prices this past week have been much less volatile.
Natural gas prices are especially important for domestic independent upstream names whose production largely includes natural gas, such as Chesapeake Energy (CHK), Southwestern Energy (SWN), Comstock Resources (CRK), and Quicksilver Resources (KWK).
Natural gas price movements are also relevant for commodity ETFs such as the U.S. Natural Gas Fund (UNG), an exchange-traded fund designed to track the price of Henry Hub natural gas (the standard benchmark for domestic natural gas prices).
Natural gas prices are low from a long-term perspective
From a long-term historical perspective, natural gas has been trading at low levels over the past few years. Prior to the financial crisis of 2008, natural gas had reached peaks of over $15.00 per MMBtu. Since 2008, a considerable amount of natural gas supply has come online without an equivalent increase in demand due to the discovery and development of large natural gas shale resources in the U.S. Many investors expect natural gas prices to remain relatively depressed, as the development of shale resources has allowed companies to produce natural gas economically at lower prices.
For companies weighted toward natural gas assets and production, prices have an important effect on valuation. Market participants and upstream energy companies monitor natural gas prices because lower prices translate into lower revenues—and so lower margins and valuation for natural gas producers. The chart below shows natural gas prices plotted against CHK’s and KWK’s stock prices over time on a percentage change basis. The graph shows that the companies’ valuations (through changes in stock price) closely relate to natural gas prices.
Despite a medium-term rally, natural gas prices remain relatively low from a long-term view
This past week, natural gas prices dropped by 4.9%. This indicates a moderately negative signal for natural gas–weighted producers in the short run. Over the medium term, prices have been up over 25% since early November 2013. However, from a wider long-term perspective (five years and longer), natural gas prices still remain relatively low, and given the seasonal nature of the recent rally, this trend may not translate into a long-term secular catalyst.
Fluctuations in natural gas prices most affect natural gas–weighted producers, such as the companies mentioned above (CHK, SWN, CRK, and KWK), and the U.S. Natural Gas Fund ETF (UNG). Investors with such holdings find it prudent to track natural gas prices. XLE, the energy sector ETF, would be affected by natural gas price movement.
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